Page 95 - DMGT401Business Environment

Business Environment

Notes 5. Restrictions on Imports: In a move to protect domestic industry, the government restricted
imports in the past. Because of this, diseconomies of scale crept the industrial sector as it
was totally a seller's market, resulting in an increase in prices. Consumers were forced to
purchase costly products made in India though they could be imported at very cheap rates.
This policy also resulted in the inefficient use of resources as scarce resources were invested
even in the production of those things which were easily available at very economical
prices abroad, and could be easily imported.
The various factors that have accelerated demand thus have resulted in the increase in prices are:
1. Growth of Population: India's population keeps rising at more than 2% per annum.
Increased population causes increase in the demand of wage goods. It also adds to the
government expenditure at all levels to provide basic amenities to the population added
and exerts pressure on demand indirectly.
2. Increment in Income and Employment: Post-liberalisation, income and employment have
increased significantly. These have resulted in greater demand for wage goods whose
supply is relatively inelastic. The result has been a continuous price rise.
3. Urbanisation: The migration of population from villages to city areas adds to the intensity
of the demand factor.
Monetary and fiscal factors have also contributed to price rise in India as they work as demand
accelerators. The following are important reasons in this respect:

1. Rising Level of Government Spending: India has witnessed a sharp rise in public expenditure
since independence. This rose from 18.5 % of NNP to around 33 % in 1980-81 and further
rose to around 45% in 1998-99. A significant part of government expenditure is on
non-developmental activities including defense, interest on public debt, administrative
expenditure, and maintenance of law and order in the country. The expenditure on these
activities leads to inflationary trends in the economy; the purchasing power of the people
increases but the supply of real goods remains more or less the same.
2. Deficit Financing: Deficit financing results in large- scale creation of money and intensifies
the price spiral. Net bank credit to the private sector also contributes to inflationary
pressures.

3.5.3 Measuring Inflation

Inflation is measured by observing the change in the prices of a large number of goods and
services in an economy. The prices of goods and services are combined to give a price index
measuring an average price level, the average price of a set of products. This price is then
adjusted for changes in the underlying basket of goods, a process called hedonic adjustment.
Inflation Rate: The inflation rate is the rate of increase of the average price level, i.e., measure
of inflation. Alternatively, the inflation rate is the rate of decrease in the purchasing power of
money.
There is no single true measure of inflation because the value of inflation will depend on the
weight assigned to each good in the index as well as the extent of the economic region being
examined.

Inflation is measured through various price indices. The following price indices used in India to
measure inflation:
1. GDP Deflator.

88 LOVELY PROFESSIONAL UNIVERSITY